Professors Allege More Accounting Problems At Demand Media

Two academics have raised more questions about accounting practices at Demand Media Inc. (NYSE: DMD), providing insight into the financial health of the operator of eHow.com, LiveStrong.com and other websites.

Accounting professors Anthony Catanach of Villanova University and Edward Ketz of Penn State, who run the Grumpy Old Accountants blog, allege that the Santa Monica, Calif., company is overly aggressive in capitalizing costs. Doing so allows a business to record lower expenses for the period in which the cost was incurred.

For example, recording a $100 expense as an intangible asset and amortizing it over five years allows a company to record only $20 in expenses for the initial year.

Costs capitalized by Demand Media relate to content, Internet-domain registration and maintenance, and internal development of software.

Over 72 percent of Demand Media's assets -- including $50 million in deferred-registration costs, $256 million in goodwill and $111 million in net intangible assets -- are intangible in nature, an astonishingly high figure that seems to support the professors' accusation of aggressive cost capitalization.

This isn't the first time critics have implied that Demand Media uses accounting gimmicks to shave losses.

When the company filed to go public in late 2010, experts and even the U.S. Securities and Exchange Commission expressed concern over its method of expensing the cost of paying content writers over five years, a practice it continues to this day.

Demand Media is currently unprofitable. Were it not for its unconventional and allegedly aggressive accounting practice, losses reported by the company would have been much larger, critics claim. This may further stoke fears that Demand Media is burning through investors' cash.

Catanach and Ketz even took issue with the way the company records cash on its balance sheet.

Demand Media, according to its 2011 annual report, considers funds transferred from its credit card service providers but not yet deposited into its bank accounts to be cash. The company doesn't specify how much of its recorded cash balance consists of such funds.

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